Envisioning Bitcoin’s future

Bitcoin is in the news again. The virtual currency’s price was falling Thursday in the wake of an IRS announcement this week that Bitcoin should be taxed as property, not a currency.

I run the Crabtree Technology portfolio on Covestor and my perspective on Bitcoin is as an investor who wants to understand it fully so that I can either invest in it, or understand how it affects the companies in which I already invest.

I’ve been studying Bitcoin and other virtual currencies for over a year. I have a B.S. in Mathematics and worked as a professional computer programmer before moving into finance over 20 years ago, so I have a passable understanding of the mining process and the underlying math of Bitcoin.

Two years from now, I believe Bitcoin will be used in ten or a hundred times as many transaction as it is currently. There will probably be many reported instances of Bitcoin being stolen both person-to-person or on a larger scale.

I’m often asked about the future of Bitcoin and where the digital currency might be in two years time and what, if anything, needs to happen to get it to that point.

In this post I’ll answer some of the most commonly-asked questions I hear on Bitcoin.

What is the biggest threat to Bitcoin’s future?

The primary threat to Bitcoin is a corruption of its essential mathematical structure. If hackers were able, for example, to counterfeit Bitcoin, it would instantly lose both value and utility. So far, however, all the screw-ups and thefts of Bitcoin have only reduced the number of Bitcoins in circulation, but haven’t increased them.

Will we ever be using Bitcoins as our primary currency?

No, we will not. We have hundreds of legitimate currencies in use worldwide; the existence of yet another isn’t going to suddenly render any or all of them obsolete. Bitcoin’s volatility, however, will prevent it from being used as a functional, day-to-day currency by individuals. And businesses may find it hard to use as a functional currency because, for example, a company purchasing raw materials in Bitcoin might subsequently encounter one of the regular devaluations vis-a-vis other currencies; this would mean they’d have to sell the finished goods at a loss if the transaction also was conducted in Bitcoin.

Will it still be niche?

Yes, but I think Bitcoin will find regular use in fairly large user group niches. First, I think it will become a useful currency in emerging or frontier markets, enabling merchants and farmers who don’t have access to banks to transact business with others in a similar financial position. Currently a businesses person might travel to a major city in order to convert local cash to a letter of credit or to another currency, then physically carry that cash to the counterparty to do business face-to-face. With Bitcoin (or another virtual currency), you could negotiate electronically, then pay via Bitcoin. This would save on transaction fees, foreign exchange fees and eliminate the physical danger of carrying cash.

Another niche will be citizens of politically or financially unstable countries using Bitcoin as an anonymous method of transporting wealth offshore to a safe haven. Think of Chinese or Russian citizens under strict capital movement controls. In this way, Bitcoin’s volatility wouldn’t even be a hindrance, because Bitcoin would only be a temporary store of value until it was safely onshore and re-converted to US dollars or Swiss francs or whatever.

What will the transaction process look like?

Transactions will be smoother and simpler. In a software-driven world, “version 2″ is typically easier-to-use than “version 1.” and this will likely be true of Bitcoin development.

ATMs certainly legitimize Bitcoin, but are in some respects, redundant. It’s an electronic currency and all you need is a handset with a Bitcoin wallet. Plus ATMs would be targets for strong-arm or armed robbery, given the “bearer instrument” nature of Bitcoin.

Could Bitcoin be regulated in the future?

Bitcoin users and relevant institutions should welcome the legitimizing force of regulation, but regulation is likely to be fairly light. Most governments seem unfazed by the existence of Bitcoin – they’ve either got bigger problems to worry about or view it as yet another avenue of commerce and thus, eventually, a flow of transactions that can be taxed. This light touch is likely to continue until it seems large amounts of potential tax revenue are being foregone.

Do speculation and price volatility pose problems for Bitcoin?

The meteoric rise has been great for the very earliest adopters, and financiers hoping to fund legitimizing businesses that can get a piece of the inevitable action. While it is true that Bitcoin lacks the stability to function as a useful day-to-day currency, it can’t be denied that despite the collapse of Mt. Gox and other screw-ups, Bitcoin transaction volumes continue to rise.

That said, uncontrolled appreciation of Bitcoin is problematic.

What are some other uses of Bitcoin we might see in the future?

Aside from the transactional possibilities, Bitcoin has potential beyond a mere currency.

I think that as time passes, people will see Bitcoin as a kind of “E-gold” where it has a cross-border acceptance of its value, and is used for temporary cross-border transit of value, but not for day-to-day small-scale transactions.

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